Tax Lawyer's Blog

Doug Lederman writing for USA Today says that the IRS is examining the executive compensation structures of 400 colleges and universities to determine whether or not they are violating the rule against private inurement:

In more than 30 reviews the Internal Revenue Service is conducting of individual colleges and universities, it is focusing mostly on issues related to executive compensation and payment (or non-payment) of tax on unrelated business income, the agency said Friday, as it released the preliminary results of its survey of 400 institutions.

The interim report offered the first official look at the information the federal tax agency has collected from a wide-ranging questionnaire it sent to colleges in 2008 to gauge their compliance with tax laws and identify possible areas for further examination — and, of course, enforcement.

The IRS focused on higher education (following a similar questionnaire it sent to hospitals), the agency said, because “colleges and universities make up one of the largest nonprofit segments in terms of revenue and assets” — and that status has made it a target for members of Congress and others in the federal government at a time of ever-tightening federal budgets.

Internal Revenue Code § 501(c)(3) contains what is known as the prohibition against private inurement. It states, in relevant part,

[N]o part of the net earnings of [the exempt organization] inures to the benefit of any private shareholder or individual…

The private inurement rule requires that none of an exempt organization’s income or assets benefit unduly a person or entity that is closely related to the exempt organization – particularly one who exercises a significant degree of control or influence over it.

The private inurement rule forces tax exempt organizations to be consistently vigilant in evaluating all proposed transactions with insiders to make sure that those transactions will not unduly benefit those insiders.

The paying out of excessive compensation is one of the most common ways in which tax exempt organizations are found to have violated the private inurement rule. And this is why the IRS is focusing it’s attention on the pay structures of colleges and universities.

Final Note: The private inurement rule does not contain a de minimis exception. As a result, an exempt organization that is found to have run afoul of the rule will be subject to revocation of its tax-exempt status regardless of the extent of which it has run afoul of the rule.

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